INFORMAL STAFF ADVISORY OPINION 04-1
This staff advisory opinion is issued in response to your recent request for our views concerning the applicability of the Federal Trade Commission's Franchise Rule ("the Rule") to your client's proposed business arrangement.
You ask whether the following proposed business arrangement constitutes a franchise under the Franchise Rule. Your client, Northeast Entrepreneur Fund, Inc. ("NEF"), has developed a trademarked business planning course, including a set of course materials. Other entities have expressed an interest in teaching the course in specific geographic areas. NEF is interested in selling rights to teach the course for a one-time lump-sum payment. The price charged would vary depending upon whether "customized training is desired" and the number of training manuals requested.
You add that the prospective purchasers are "established businesses" with "business objectives similar to the objectives of" NEF. You state that revenue derived from teaching the course would not be a significant part of their overall income. Similarly, selling the course would not be a significant part of NEF's operations. Finally, you add that neither NEF nor the purchasers would have significant control over the other's operations.
II. THE DEFINITION OF FRANCHISE
We begin our analysis by noting that the term "franchise" refers to a continuing commercial relationship. In your letter, you contend that there is no continuing relationship because purchasers will make a one-time lump-sum payment to NEF for the right to teach the course.
In the Statement of Basis and Purpose accompanying the Rule, the Commission stated that the Rule would not apply to commercial relationships that do not involve a course of dealing over a period time, nor to relationships in which the characteristics of a franchise (as discussed more fully below) are not expected to be present on a continuing basis. 43 Fed. Reg. 59,614, 59,700 (Dec. 21, 1978). Thus, in determining whether a relationship is "continuing," we must consider the prospective purchaser's understanding, based on the seller's representations, whether the parties expect to engage in a course of dealings over time. The payment of a one- time lump-sum fee alone is not determinative. Where, for example, a licensee pays a single upfront fee, but continues to receive supplies or other services over the course of the relationship, we might conclude that the parties' relationship is "continuing." If, as you suggest, NEF and the purchasers enter into a single deal involving the sale of a limited number of educational materials, and there are no additional purchases from NEF or payments made to NEF over the course of time, then it would appear that the relationship between the parties is not continuing. On the other hand, if purchasers reasonably understand that they have the right to purchase additional course materials, receive continuing services, or that they must make royalty or any other payments to NEF over time, then the relationship between the parties may be deemed "continuing."(1)
To be covered by the Franchise Rule, a business arrangement must also satisfy the three definitional elements of a "franchise" set forth in the Rule: (1) the distribution of goods or services associated with the franchisor's trademark or trade name; (2) the exercise of significant control over, or the provision of significant assistance to, the franchisee; and (3) the required payment of at least $500 within six months of signing of an agreement. 16 C.F.R. § 436.2(a)(1)(i). We address each of these elements below.
1. Distribution of Goods or Services Associated with the Franchisor's Trademark or Trade Name
The first definitional element of a franchise is trademark. The Rule provides that the trademark element will be satisfied under one of two conditions:
1. The franchisee offers, sells, or distributes goods, commodities or services that are identified by a trademark; or
2. The franchisee indirectly or directly is required or advised to meet prescribed quality standards where the franchisee operates under a name using the trademark.
16 C.F.R. § 436.2(a)(1)(i)(A)(1) and (2).
In your letter, you state that NEF's business planning course is associated with NEF's registered trademark. This is sufficient to satisfy the Rule's first definitional element.
2. Significant Control or Assistance
As noted above, you state that your client imposes no significant controls over the purchasers' business operations. This statement, however, is conclusory: other than stating that your client will grant exclusive territories, you do not detail the types of controls, if any, that NEF might impose, preventing us from making an independent determination of "significance." Moreover, you do not specifically address assistance. From your letter, it is clear that NEF at least offers "customized training." The question then becomes what level of control and assistance might be present and whether they rise to the level of being "significant."
Further, we note that the Commission stated in its Final Interpretative Guides that "significance" is a "function of the degree of reliance that franchisees are reasonably likely to place upon the controls or assistance." See Final Interpretive Guides, 44 Fed. Reg. at 49,967. This is especially relevant where purchasers are inexperienced in the particular business. Id. The Commission examines "significant control and assistance" on a case-by-case basis. Among other things, the Commission considers the nature of the particular industry, the level of sophistication of the investors, as well as the importance of the assistance and control offered by the seller to the purchasers. Id. See also Statement of Basis and Purpose, 43 Fed. Reg. 59,614, 59,701 (December 21, 1978).
In your letter, you state that the purchasers will be well-established businesses that share NEF's objectives. You also state that proceeds from teaching the course will constitute a small portion of the purchasers' overall business revenues. You do not say, however, whether the businesses are experienced in the field of business education. Even if a business is well-established, it does not necessarily follow that it has the experience and know-how to successfully operate in a different line of business. See Advisory 97-7, Bus. Franchise Guide (CCH), ¶ 6487 (hospital not necessarily experienced in operating a travel clinic).
On the other hand, if the purchasers are, in fact, experienced in teaching business and related fields, then it would appear that the purchasers are not likely to place great reliance on NEF in teaching the NEF business planning course. Further, the Commission has noted that reliance is proportionate with financial risk (e.g., the risk assumed by adding a new product line). It appears from your letter that purchasers may engage in other business beyond teaching the course. If the portion of the purchasers' overall sales attributable to teaching the course is small, then reliance might be lacking.
Moreover, the Commission has stated that controls and assistance must be over the franchisee's "entire method of operation - not its method of selling a specific product or products which represent a small part of the franchisee's business." The Commission reasoned:
Controls or assistance directed to the sale of a specific product which have, at most, a marginal effect on a franchisee's method of operating the entire business will not be considered in determining whether control or assistance is "significant."
44 Fed. Reg. at 49,967.
Accordingly, depending upon the nature of the purchasers' prior business experience, it is possible that the contemplated controls and assistance may not rise to the level of significance contemplated by the Rule.
3. Minimum Payment
In your letter, you state that licensees will make a payment, you do not specify the minimum amount. As noted above, a franchise relationship will be covered by the Rule if the franchisee pays, or commits to make a payment, of at least $500 in the first six months of operations. In the absence of more detailed information, we cannot determine whether the minimum payment requirement is satisfied in this instance.
III. FRACTIONAL FRANCHISE EXEMPTION
In your letter, you suggest that your client's proposed business relationship should fall outside the Rule because the revenue derived from teaching the course will constitute a small portion of the purchasers' overall income. Without saying so, you essentially contend that the relationship satisfies the requirements of the fractional franchise exemption.
There are two prerequisites to the fractional franchise exemption: (1) two years of experience in the type of business represented by the franchise; and (2) sales arising from the relationship represent no more than 20% of the total dollar volume of sales by the franchisee. 16 C.F.R. at § 436.2(a)(h). Your letter states that the purchasers will be well-established businesses. If they are experienced in business education, it is likely that they will satisfy the exemption's "two years of experience" prong. However, we have no basis to determine whether the second prong - no more than 20% of total dollar value - is satisfied. In previous advisories, we cautioned that franchisors cannot make bald assertions about potential sales. All franchisors claiming the exemption have the burden of establishing by some evidence - such as market data - a reasonable basis for the parties' belief, pre-sale, that income derived by the franchisee from the relationship will total no more that 20% of total dollar volume in the first year. See, e.g., Advisory 99-5, Bus. Franchise Guide (CCH), ¶ 6502 (1999); Advisory 98-6, id, at ¶ 6495 (1998); Advisory 97-1, id, at ¶ 6481 (1997); Advisory 96-2, id., at ¶ 6477 (1996). In this instance, you have provided no data beyond the mere assertion that sales attributable to teaching the course will constitute an insignificant portion of the purchasers' overall sales. That is an insufficient basis for us to conclude that the fractional franchise exemption applies to your client.
Based upon the limited information you have provided, we cannot determine definitively whether your client's proposed business arrangement falls outside of the Rule. If your client's relationship with the purchasers is for a one-time sale of training materials, without any continuing rights or obligations, then the arrangement may not constitute a continuing commercial relationship. In addition, if the purchasers are experienced in the field of business education, then it is likely that they may not rely on your client in teaching the business planning course. If so, then the second definitional element - significant assistance and control - may be lacking. In that scenario, it is possible that your client's proposed business arrangement would not be covered by the Commission's Franchise Rule.
Please be advised that our opinion is based on all the information furnished in your request. This opinion applies only to your client and to the extent that actual company practices conform to the material submitted for review. Please be advised further that the views expressed in this letter are those of the FTC staff. They have not been reviewed, approved, or adopted by the Commission, and they are not binding upon the Commission. However, they do reflect the opinions of the staff members charged with enforcement of the Franchise Rule.
Date: January 21, 2004
Franchise Rule Staff
1. We also note that NEF is essentially granting a license to the purchasers to use its trademark over a period of time to teach the business course. As long as a license is in force, giving the parties rights and obligations, the relationship created by that license agreement arguably is continuing for purposes of the Franchise Rule.